Capital Punishment

In his new work, Bruce Bartlett—one of the original supply-side economists—makes a cogent case for restructuring our tax system. His premise is exactly right: “The goal of tax reform, which Republicans used to believe in, should be tax neutrality.” Given how high our debt levels are, any new system has to be revenue-neutral. But the right kind of reform, Bartlett maintains, should have “the lowest possible rates on the broadest possible base.” America would be better off with a system that emphasizes taxing consumption rather than one that heavily taxes capital investment.

The United States has the most onerous corporate tax system in the world, with its 35 percent and the 7.65 percent employer portion of the payroll tax. In light of that, it’s not surprising there was a net loss of 3.7 million private-sector jobs in the U.S. from 2000 through 2010. During that decade the only gain in employment came from growth in government jobs.

Our current system is an example of “upside-down economics.” We reward corporate debt while punitively taxing capital investment, employment, and savings—the engines of growth. As investment guru Mark Faber has observed, “The government continuously implemented policies to boost consumption when everyone should know that an economy will grow in a sustained way only through the implementation of policies that foster capital formation.”

The Benefit and the Burden explains the consequences of a corporate tax system that rewards debt while double-taxing corporate profits:

Interest payments are a deductible business expense that reduces taxes; dividend payments are not. Many economists believe that the favored treatment of debt has led corporations to become overleveraged, contributing to bankruptcies during economic slowdowns. While dividend payments can be suspended when corporate income falls, interest payments must be made on schedule regardless of circumstances.

There’s an irony here, as Bartlett notes. Despite its very high rate, our system of corporate taxes “has been a declining source [of revenue] for many years.”

In the early 1950s taxes on corporations constituted 33 percent of federal revenue. In 2010 it was less than 10 percent. The main reason, historically, for the decline in corporate tax revenue is that debt, with its tax-deductible interest payments, has replaced equity as the major source of corporate finance.”

Our business-tax structure has been great for private-equity moguls and leveraged buy-out operators like Mitt Romney and Stephen Schwarzman, who have made fortunes gaming the system. But it has been destructive to the long-term health of many U.S. companies and to American workers who have lost their jobs as a consequence of tax incentives that encourage companies to pile up debt.

Bartlett reviews the pros and cons of popular tax-reform proposals such as the flat tax and FairTax, and he finds them wanting. He believes that the FairTax—a national sales tax in the range of 23 percent—is unworkable, citing experts who have “concluded that a rate significantly higher than 23 percent would be necessary for it to be revenue-neutral.”

From here, Bartlett builds the case for his own favored reform, a value-added tax. The VAT is similar to the FairTax in that it taxes from consumption rather than income. But because the VAT is collected at each stage of production—with credits provided against previously paid taxes—it bypasses many of the weaknesses inherent in a traditional retail sales tax, such as double taxation on certain capital purchases. This credit feature of the VAT makes revenue collection largely self-enforcing, as businesses are encouraged to report taxes paid on capital purchases so they can be properly reimbursed. Bartlett correctly heralds the VAT as “designed to overcome the administrative problems” of the FairTax while raising “more revenue at less economic cost than any other tax.”

Yet as Bartlett repeatedly points out, the most powerful opposition to this idea comes from the right—from the opinion pages of the Wall Street Journal to the powerful political apparatus developed over the decades by Grover Norquist and his organization, Americans for Tax Reform. In light of the fact that conservatives historically have recognized the value of savings and the dangers of excess consumption, the strident opposition of so many influential voices on the right to a border-adjusted consumption tax seems incongruous.

Bartlett is far from the only conservative economist who views the VAT as a preferable system: “In the 1970s and early 1980s many conservatives, such as Norman Ture, undersecretary of the Treasury for tax and economic policy, and Murray Weidenbaum, chairman of the Council of Economic Advisors, both for President Reagan, supported an American VAT,” he notes.

Why should conservatives support a border-adjusted consumption tax? Among other reasons, says Bartlett, “In practice the consumer pays all the tax.” Whether the VAT replaces the entire income tax system or just the corporate income tax, everybody would contribute: “A VAT would get all Americans to pay for the federal government’s general operation.” Right now 47 percent of Americans pay no income taxes.

Moreover, a VAT “can be assessed on imports and rebated on exports. … The purpose is to provide neutrality, so that goods traveling through different countries bear only the tax imposed in the country of final sale.” The practical effect is that all goods and services coming into the U.S. would have to pay into out tax system, unlike now. An 8 percent border-adjusted consumption tax on all goods and services imported into the U.S. as a replacement for our corporate income tax would level the playing field with our trading competitors, who currently enjoy an average 18 percent tax advantage over us on all exports and imports.

American industry would immediately become more competitive and drive our trade deficits lower: “since the tax would also apply at the border on goods and services that now enter the country tax-free, it would shift the tax burden partly onto foreigners, given that the United States runs a large trade deficit. Thus the taxes levied on imports would exceed rebates on exports.” Notably, virtually all our trading competitors have a border-adjusted consumption tax.

Bartlett takes on the arguments against a value-added tax. The principal complaint of many conservatives is that the VAT is “a money machine”: “in their minds, its primary virtue—the ability to raise large amounts of revenue at low deadweight cost—is also its primary vice.” The fear is that once a VAT is put in, politicians will easily be able raise its rate.

This is a legitimate concern. What’s more, if you enact a VAT while merely lowering personal and corporate income tax rates, there is a risk that politicians will later ratchet all rates higher again. That’s why I believe you have to eliminate the corporate and/or personal income tax completely. You have to pull the existing income-tax structure out by its roots, otherwise the odds are that there will be higher taxes on both consumption and income in the future.

When you have an Internal Revenue Code so laden with special provisions and loopholes that profitable companies like General Electric pay nothing in corporate income taxes while they benefit from shipping American jobs overseas, something is badly wrong. The American people are ahead of our political leaders in understanding that our system is broken and gravely in need of reform. Look at the enthusiasm former Republican presidential candidate Herman Cain attracted with his 9-9-9 plan, even with all of its flaws.

But where will the leadership and political courage come from to take on this thorny problem? Bartlett suggests it will require a Republican president and Democratic Congress. He seems to think that Republicans won’t support reform along the lines he proposes. I am not so sure. In any event, Bruce Bartlett has waded into the debate on tax policy with a thoughtful argument for the necessity of reform.

So basically Mr. Bartlett’s solution is to keep the size of the government exactly the same (a long time supply-side goal of course, which thoroughly exposes the lie that they were ever conservatives) and bribe corporations to stay here. I could hardly imagine a more evil proposal. I will be reading this book myself to make sure this review isn’t merely a complex satire.

If you want to see how this would work, check to the North. Canada has had a VAT, called the GST/HST for the last 20 years.1,000 pages of tax act plus multiple of thousands of pages of explanatory notes, tax memorandums, etc

Being that the US has an annual trillion dollar revenue shortfall, unless we want this beacon of liberty to go bankrupt revenue neutrality is a brain dead concept. Personal, corporate, and other sources of revenue tax rates must rise to historical norms or this country will go bankrupt.

Especially as the deficits and national debt crisis come from the President Reagan and W Bush’s tax rate cuts. These tax cuts were not supply side tax cuts but the most ineffective stimulus package possible that has been engages in for 3 decades.

If you want to discourage debt and corporations loading up on debt interest payments, make debt not tax deductible.This would put it on balance with dividends and provide desperately needed revenue for the treasury.

The reason 45% don’t pay income tax is because the right wing economic policies of the last three decades has made the middle class poorer and an ever larger segment of the population destitute and poor.

A thirty years class war against the middle class will do that sort of thing!!

Being that the US federal government, once you take out military spending, has the lowest expenditure of government spending in the G8 and G20, why are conservative buying the radical right’s tripe about government spending being out of control.

I other nations use a VAT Tax to make imports more expensive and exports cheaper then how can the US continue to remain outside this structure.

Using VAT taxes on imports to pay for social programs which we here in the US finance by payroll taxes + government only creates a dis-incentive to employment by making it appear US employees are over-paid and uncompletitive.

another analogy is metric versus english measurement

Its like the US is still playing checkers while the rest of the world is playing chess.

We are not the worlds military, or police or standards committee. The US has a global outlook but we cannot engage the world as globalists (ie a nation whose citizens have no value of sovereignty, borders, nationhood). The way the US is engaging the world is pure insanity of the left and leftists.

Interesting article. I’m not sure how a tax and rebate administered at every level of production would be easier to administer than a simple sales tax at the point of sale to the end user– a process nearly all merchants are already equipped to administer.

By the way, I always appreciate the dual assertion by progressives that America is both a beacon of liberty AND not taxing and spending enough.

Sounds like I get another opportunity to introduce a well-meaning fellow to the foundational principles of liberty. Spend a lazy Sunday reading and viewing the posts at mises.org. There are are a lot of good Insights for you there, Insightful Ilias.

The VAT in Canada resulted in tax raises in every other tax as well. There is NOTHING that is not subject to being taxed at every stage of the production and transfer level – insurance, financial transactions, etc. The government is into your life in absolutely everything you do at every level, with a huge increase in accounting costs and paperwork. You even have to pay VAT on photocopies you make yourself internally, complete with compulsory records and submissions. There is no area which remains outside of government purview and oversight. It is claimed that you get credits back from all this infinity of multilevel taxation – but that is something filed for after the accumulated taxes are paid.

The result is government that is bloated an enormous with huge increases in compliance, record-keeping, etc. It creates an environment in which absolutely no financial activity occurs without deep government involvement and profit occurs at each level, regardless of the profit or loss of the transaction to those actually conducting it.

The VAT is best characterized as a mandated, state-sponsored “vigorish.”